When you change jobs or retire, you have several options for the money in your 401(k). You can typically transfer that money to an IRA, leave it in the plan, or cash out. In many cases, it’s smart to move your savings into an IRA.
Unfortunately, the process can be confusing and intimidating, so most people do nothing. As a result, they leave savings with an employer that they no longer have any connection to, and one they might even dislike or distrust.
Why Transfer Your 401(k) to an IRA?
Why would you consider moving savings in an old 401(k) plan to an IRA? The main reason is to keep control over your money — in an IRA, you get to decide what happens with the money. You choose where to invest and how much you pay in fees, and you don’t need anybody’s authorization to take money out of the account.
More control: In your 401(k), your employer controls everything. Employers choose vendors for the plan, which determines the investment lineup available. Those might not be investments you like, and they might be more expensive than you want. 401(k) plans also require extra steps when you want to withdraw funds: Somebody needs to verify that you are eligible to access your money before you’re allowed to do anything.
Easy withdrawals: If you need access to your 401(k) savings for any reason, it’s just easier when the money is in an IRA. In most cases, you call your IRA provider or request a withdrawal online. Depending on what you own in your account, the funds might go out as soon as the next business day.
Complicated situations: In addition to basic control of your money, there are several other situations in which you might want to transfer from a 401(k) to an IRA. The possibilities are too numerous to cover here, so it’s important to research and understand how your 401(k) compares to an IRA. A few examples include:
- Options at death: You might be interested in how the funds are handled in the event of your death. Sometimes beneficiaries have more flexible options with an IRA. Familiarize yourself with the rules governing these accounts and do what’s best for you and your family.
- Frozen plans: If your company is involved in a merger or certain types of investigations, the 401(k) plan might be frozen. If that happens, even for a short time, you may have to wait to access your money.
- Missing signers: Sometimes, especially with smaller companies, a company goes out of business, and it’s hard to find the person who can authorize your withdrawal.
How to Transfer From Your 401(k) to an IRA
When you’re ready to make the transfer, you need to do three things:
- Verify that this is really the best option. Review the examples below describing potential pitfalls, and evaluate potential complications.
- Gather information about your IRA. If you don’t already have one, we’ll discuss opening one below. You need your IRA custodian’s name (Vanguard, for example), your account number, and a delivery address.
- Request the transfer. Contact your former employer to provide instructions. You can use this sample text: “I’d like to roll my 401(k) over to an IRA. Please provide instructions on how to proceed.”
Unfortunately, you typically have to go through your former employer or a vendor they use. With many 401(k) plans, you cannot request a transfer using paperwork from the receiving IRA custodian.
Who to contact: If you work for a large company, you can most likely contact your 401(k) provider directly. For example, contact Fidelity, Vanguard or whatever website you use to manage your account (alternatively, call whoever prints your 401(k) statements). If you work for a smaller company, you may need to contact the human resources “department,” which might just be the person who hired you. Either way, you eventually need one of the following:
- A distribution request form, or
- A phone number for providing your instructions, or
- A website that can take instructions
What to say: It’s critical to include the following details as you provide instructions:
- You want to do a “direct rollover” to an IRA.
- The check should not be payable to you personally.
During the rollover process, you provide instructions on who to make a check payable to. In most cases, that would be your IRA provider (a brokerage house, mutual fund company, or bank). It is best to provide an account number, when available, but that might not be required. If the check is mailed to your home, you can write your IRA account number on the check before forwarding it to your IRA provider.
If you don’t already have an IRA, you need to open one. You can start by opening an “empty” IRA, which you will fund with your 401(k) rollover. You have numerous options when it comes to opening an IRA. If you want to keep your money as safe as possible, a bank or credit union can offer savings accounts and certificates of deposit (CDs) with a government guarantee. If you want to invest with the potential for more growth, any mutual fund company, online broker, or financial planner can open an IRA for you. Just ask for instructions on opening an account.
When Not to Transfer to an IRA
You now know some of the benefits of transferring your 401(k) to an IRA. But control over your money isn’t the only thing that matters, and you may have other priorities. Potential pitfalls are impossible to cover exhaustively, but a few examples may offer food for thought.
Creditor protection: Depending on state laws, money in IRAs might be treated differently, and a 401(k) might offer more protection (or less). Federal law often applies to ERISA-covered 401(k) plans, while state laws cover IRAs. However, there is some federal protection for IRAs in bankruptcy. When you owe federal tax debts assets are due to an ex-spouse, protection is usually limited.
Between age 55 and 59.5: When you’re at least 55 years old — but not yet 59 1/2 years old — you might want to have at least some of your money in the 401(k) plan. 401(k)s allow you to pull money out without penalty after age 55 (for most employees, but not everybody — speak with a CPA to verify your details). IRAs, on the other hand, require that you wait until age 59 ½ to avoid an early-withdrawal penalty of 10% on certain distributions. There are always exceptions and workarounds, but those are the basic rules. If you intend to spend your 401(k) savings between the ages of 55 and 59 1/2, keep this in mind before making a transfer.
Roth conversions: If you plan to convert Traditional savings to Roth IRA holdings, keeping funds in a 401(k) might simplify your life. Doing so could minimize the amount of pre-tax money that goes into pro-rata calculations when you convert. Money in your 401(k) might be excluded from those calculations, but verify your plans with a CPA.
Important: The different rules that apply to 401(k) and IRA accounts are confusing. Discuss any transfers with a professional advisor before you make any decisions. This article is not tax advice, and you need to verify details with a CPA. Likewise, only an attorney authorized to work in your state can provide guidance on legal matters. Approach Financial, Inc. does not provide tax or legal services.